nep-dge New Economics Papers
on Dynamic General Equilibrium
Issue of 2010‒04‒11
23 papers chosen by
Christian Zimmermann
University of Connecticut

  1. Impulse response identification in DSGE models By Martin Fukac
  2. Asset pricing, habit memory, and the labor market By Ivan Jaccard
  3. Staggered Wages, Sticky Prices, and Labor Market Dynamics in Matching Models By Janett Neugebauer; Dennis Wesselbaum
  4. Do credit constraints amplify macroeconomic fluctuations? By Zheng Liu; Pengfei Wang; Tao Zha
  5. Social security, benefit claiming, and labor force participation: a quantitative general equilibrium approach By Selahattin Imrohoroglu; Sagiri Kitao
  6. Search, Nash Bargaining and Rule of Thumb Consumers By J.E. Boscá; R. Doménech; J. Ferri
  7. Economic Growth with Bubbles By Alberto Martin; Jaume Ventura
  8. Liquidity-saving mechanisms in collateral-based RTGS payment systems By Marius Jurgilas; Antoine Martin
  9. Training or search? evidence and an equilibrium model By Jun Nie
  10. Structural macro-econometric modelling in a policy environment By Martin Fukac; Adrian Pagan
  11. Insuring consumption using income-linked assets By Andreas Fuster; Paul S. Willen
  12. Household decisions, credit markets and the macroeconomy: implications for the design of central bank models By John Muellbauer
  13. Identification problems in the solution of linearized DSGE models By Jean Pietro Bonaldi
  14. Investment-specific technology shocks and international business cycles: an empirical assessment By Federico S. Mandelman; Pau Rabanal; Juan F. Rubio-Ramírez; Diego Vilán
  15. Large Fluctuations in Consumption in Least Developed Countries By Kodama, Masahiro
  16. Fiscal Multipliers and the Labour Market in the Open Economy By Faia, Ester; Lechthaler, Wolfgang; Merkl, Christian
  17. Booms and Busts in Asset Prices By Klaus Adam; Albert Marcet
  18. Euler-equation estimation for discrete choice models: a capital accumulation application By Russell Cooper; John Haltiwanger; Jonathan L. Willis
  19. Imperfect credit markets: implications for monetary policy By Vlieghe, Gertjan
  20. A quantitative theory of the gender gap in wages By Andrés Erosa; Luisa Fuster; Diego Restuccia
  21. Chained Credit Contracts and Financial Accelerators By Naohisa Hirakata; Nao Sudo; Kozo Ueda
  22. On the mechanics of firm growth By Erzo G.J. Luttmer
  23. Catching-up with the "locomotive": a simple theory By Raouf Boucekkine; Benteng Zou

  1. By: Martin Fukac
    Abstract: Dynamic stochastic general equilibrium (DSGE) models have become a widely used tool for policymakers. This paper modifies the global identification theory used for structural vector autoregressions, and applies it to DSGE models. We use this theory to check whether a DSGE model structure allows for unique estimates of structural shocks and their dynamic effects. The potential cost of a lack of identification for policy oriented models along that specific dimension is huge, as the same model can generate a number of contrasting yet theoretically and empirically justifiable recommendations. The problem and methodology are illustrated using a simple New Keynesian business cycle model.
    Date: 2010
  2. By: Ivan Jaccard (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
    Abstract: This article studies the asset pricing and the business cycle implications of habit formation in a production economy with capital adjustment costs and endogenous labor supply. A specification of internal habit in the mix of consumption and leisure which minimizes the wealth effect on labor supply is introduced into an otherwise standard real business cycle model. This mechanism enhances the model’s ability to explain asset pricing puzzles. JEL Classification: G12, E32, J22.
    Keywords: Equity Premium Puzzle, Labor Supply, Adjustment Costs.
    Date: 2010–03
  3. By: Janett Neugebauer; Dennis Wesselbaum
    Abstract: This paper investigates the role of staggered wages and sticky prices in explaining stylized labor market facts. We build on a partial equilibrium search and matching model and expand the model to a general equilibrium model with sticky prices and/or staggered wages. We show that the core model creates too much volatility in response to a technology shock. The sticky price model outperforms the staggered wage model in terms of matching volatilities, while the combination of both rigidities matches the data reasonably well
    Keywords: Search and Matching, Staggered Wages, Sticky Prices
    JEL: E24 E32 J64
    Date: 2010–03
  4. By: Zheng Liu; Pengfei Wang; Tao Zha
    Abstract: Previous studies on financial frictions have been unable to establish the empirical significance of credit constraints in macroeconomic fluctuations. This paper argues that the muted impact of credit constraints stems from the absence of a mechanism to explain the observed persistent comovements between housing prices and business investment. We develop such a mechanism by incorporating two key features into a dynamic stochastic general equilibrium model: We identify shocks that shift the demand for collateral assets and allow productive agents to be credit-constrained. A combination of these two features enables our model to successfully generate an empirically important mechanism that amplifies and propagates macroeconomic fluctuations through credit constraints.
    Date: 2010
  5. By: Selahattin Imrohoroglu; Sagiri Kitao
    Abstract: We build a general equilibrium model of overlapping generations that incorporates endogenous saving, labor force participation, work hours, and Social Security benefit claims. Using this model, we study the impact of three Social Security reforms: 1) a reduction in benefits and payroll taxes; 2) an increase in the earliest retirement age, to sixty-four from sixty-two; and 3) an increase in the normal retirement age, to sixty-eight from sixty-six. We find that a 50 percent cut in the scope of the current system significantly raises asset holdings and the labor input, primarily through higher participation of older workers, and reduces the shortfall of the Social Security budget through a reduction in early claiming. Increasing the normal retirement age also raises saving and the labor supply, but the effects are smaller. Postponing the earliest retirement age has only a negligible effect. When the projected aging of the population is taken into account, the case for a reform that encourages labor force participation of the elderly appears to be much stronger.
    Keywords: Labor supply ; Social security ; Employee fringe benefits ; Retirement ; Saving and investment
    Date: 2010
  6. By: J.E. Boscá; R. Doménech; J. Ferri
    Abstract: This paper analyses the effects of introducing typical Keynesian features, namely rule-of-thumb consumers and consumption habits, into a standard labour market search model. It is a well-known fact that labour market matching with Nash-wage bargaining improves the ability of the standard real business cycle model to replicate some of the cyclical properties featuring the labour market. However, when habits and rule-of-thumb consumers are taken into account, the labour market search model gains extra power to reproduce some of the stylised facts characterising the US labour market, as well as other business cycle facts concerning aggregate consumption and investment behaviour.
    Keywords: general equilibrium, labour market search, habits, rule-of-thumb consumers
    JEL: E24 E32 E62
    Date: 2009–06
  7. By: Alberto Martin; Jaume Ventura
    Abstract: We develop a stylized model of economic growth with bubbles. In this model, financial frictions lead to equilibrium dispersion in the rates of return to investment. During bubbly episodes, unproductive investors demand bubbles while productive investors supply them. Because of this, bubbly episodes channel resources towards productive investment raising the growth rates of capital and output. The model also illustrates that the existence of bubbly episodes requires some investment to be dynamically inefficient: otherwise, there would be no demand for bubbles. This dynamic inefficiency, however, might be generated by an expansionary episode itself.
    JEL: E32 E44 O40
    Date: 2010–04
  8. By: Marius Jurgilas; Antoine Martin
    Abstract: This paper proposes a simple mechanism of capital taxation that is negatively correlated with labor supply. Using a life-cycle model of heterogeneous agents, I show that this tax scheme provides a strong work incentive when households possess large assets and high productivity later in the life cycle, when they would otherwise work less. This reformed system also adds to the saving motive and raises aggregate capital. Moreover, the increased economic activities expand the tax base, and the revenue-neutral reform results in a lower average tax rate. My findings show that this tax scheme improves long-run welfare and that the majority of current generations would experience a welfare gain from a transition to the reformed system.
    Keywords: Payment systems ; Bank liquidity
    Date: 2010
  9. By: Jun Nie
    Abstract: Training programs are a major tool of labor market policies in OECD countries. I use a unique panel data set on the labor market experience of individual German workers between 2000 and 2002 to estimate a dynamic model of search and training, which allows me to quantify the impact of training programs and unemployment benefits on employment, unemployment, output, and the government expenditures. ; The model extends Ljungqvist and Sargent (JPE, 1998) by incorporating a training decision and a broader menu of unemployment benefits. Government-sponsored training programs feature a key trade-off with respect to unemployment insurance programs: they offer more generous unemployment benefits but require more time and effort from workers to generate higher skills. As a result, unemployed workers with different human capital and benefits make different decisions about training, search, and job acceptance. ; I use the model to quantitatively study the recent reforms implemented in Germany and run more counterfactual experiments. I simulate the transition path under back-to-back unexpected reforms in 2003-2006 and find the dynamics of the model's unemployment rates are close to the data. In a counterfactual experiment in which I model an economy with a German-like training system and a US-like unemployment benefit structure (roughly, benefits are lower), I find that employment and output rise substantially.
    Date: 2010
  10. By: Martin Fukac; Adrian Pagan
    Abstract: In this paper we review the evolution of macroeconomic modelling in a policy environment that took place over the past sixty years. We identify and characterise four generations of macro models. Particular attention is paid to the fourth generation -- dynamic stochastic general equilibrium models. We discuss some of the problems in how these models are implemented and quantified.
    Date: 2010
  11. By: Andreas Fuster; Paul S. Willen
    Abstract: Shiller (2003) and others have argued for the creation of financial instruments that allow households to insure risks associated with their lifetime labor income. In this paper, we argue that while the purpose of such assets is to smooth consumption across states of nature, one must also consider the assets' effects on households' ability to smooth consumption over time. We show that consumers in a realistically calibrated life-cycle model would generally prefer income-linked loans (with a rate positively correlated with income shocks) to an income-hedging instrument (a limited liability asset whose returns correlate negatively with income shocks) even though the assets offer identical opportunities to smooth consumption across states. While for some parameterizations of our model the welfare gains from the presence of income-linked assets can be substantial (above 1 percent of certainty-equivalent consumption), the assets we consider can only mitigate a relatively small part of the welfare costs of labor income risk over the life cycle.
    Keywords: Risk management
    Date: 2010
  12. By: John Muellbauer
    Abstract: It is widely acknowledged that the recent generation of DSGE models failed to incorporate many of the liquidity and financial accelerator mechanisms revealed in the global financial crisis that began in 2007. This paper complements the papers presented at the 2009 BIS annual conference focused on the role of banks and other financial institutions by analysing the role of household decisions and their interplay with credit conditions and asset prices in the light of empirical evidence. In DSGE models without financial frictions, asset prices are merely a proxy for income growth expectations and play no separate role. On UK aggregate consumption evidence, section 2 of the paper shows this is strongly contradicted by the data, for all possible discount rates and both for a perfect foresight and an empirical rational expectations approach to measuring income expectations. However, an Ando-Modigliani consumption function generalised to include a role for liquidity, uncertainty, time varying credit conditions, wealth and housing collateral effects, as well as income expectations, explains the data well. Section 3 reports new evidence on the striking rejection on aggregate data of the consumption Euler equation central to all DSGE models. Section 4 shows that UK micro evidence is consistent with the generalised Ando-Modigliani model. Section 5 discusses the limitations of recent DSGE models with financial frictions and housing. Section 6 discusses some business cycle implications of amplification mechanisms and non-linearities operating via households and residential construction. It reconsiders econometric methodology appropriate for designing better evidence-based central bank policy models.
    Keywords: household decisions, housing markets, wealth, business cycle models, consumption
    Date: 2010–03
  13. By: Jean Pietro Bonaldi
    Abstract: This article analyzes identification problems that may arise while linearizing and solving DSGE models. A criterion is proposed to determine whether or not a set of parameters is partially identifiable, in the sense of Canova and Sala (2009), based on the computation of a basis for the null space of the Jacobian matrix of the function mapping the parameters with the coefficients in the solution of the model.
    Date: 2010–03–28
  14. By: Federico S. Mandelman; Pau Rabanal; Juan F. Rubio-Ramírez; Diego Vilán
    Abstract: In this paper, we first introduce investment-specific technology (IST) shocks into an otherwise standard international real business cycle model and show that a thoughtful calibration of them along the lines of Raffo (2009) successfully addresses several of the existing puzzles in the literature. In particular, we obtain a negative correlation of relative consumption and the terms of trade (Backus-Smith puzzle), as well as a more volatile real exchange rate, and cross-country output correlations that are higher than consumption correlations (price and quantity puzzles). Then we use data from the Organisation for Economic Co-operation and Development for the relative price of investment to build and estimate these IST processes across the United States and a "rest of the world" aggregate, showing that they are cointegrated and well represented by a vector error–correction model. Finally, we demonstrate that, when we fit such estimated IST processes into the model, the shocks are actually powerless to explain any of the existing puzzles.
    Date: 2010
  15. By: Kodama, Masahiro
    Abstract: The objective of this paper is to shed light on mechanism which increases fluctuation in consumption of least developed countries. In general large fluctuation in consumption makes consumers worse off. This fact suggests that accumulation of knowledge on the generating mechanism of the large consumption fluctuation very likely contributes to welfare improvement of the least developed countries, through policies stabilizing consumption. We specifically investigated the fluctuation in consumption, through the numerical analysis with a dynamic macroeconomic model.
    Keywords: Consumption, LDC, Developing countries
    JEL: E21 E32 F41
    Date: 2010–03
  16. By: Faia, Ester (Goethe University Frankfurt); Lechthaler, Wolfgang (Kiel Institute for the World Economy); Merkl, Christian (Kiel Institute for the World Economy)
    Abstract: Several contributions have recently assessed the size of fiscal multipliers both in RBC models and New Keynesian models. None of the studies considers a model with frictional labour markets which is a crucial element, particularly at times in which much of the fiscal stimulus has been directed toward labour market measures. We use an open economy model (more specifically, a currency area calibrated to the European Monetary Union) with labour market frictions in the form of labour turnover costs and workers’ heterogeneity to measure fiscal multipliers. We compute short and long run multipliers and open economy spillovers for five types of fiscal packages: pure demand stimuli and consumption tax cuts return very small multipliers; income tax cuts and hiring subsidies deliver larger multipliers, as they reduce distortions in sclerotic labour markets; short-time work (German "Kurzarbeit") returns negative short-run multipliers, but stabilises employment. Our model highlights a novel dimension through which multipliers operate, namely the labour demand stimulus which occurs in a model with non-walrasian labour markets.
    Keywords: fiscal multipliers, fiscal packages, labour market frictions
    JEL: E62 H30 J20 H20
    Date: 2010–03
  17. By: Klaus Adam (Mannheim University and CEPR (E-mail: adam@mail.; Albert Marcet (London School of Economics and CEPR (E-mail:
    Abstract: We show how low-frequency boom and bust cycles in asset prices can emerge from Bayesian learning by investors. Investors rationally maximize infinite horizon utility but hold subjective priors about the asset return process that we allow to differ infinitesimally from the rational expectations prior. Bayesian updating of return beliefs then gives rise to self-reinforcing return optimism that results in an asset price boom. The boom endogenously comes to an end because return optimism causes investors to make optimistic plans about future consumption. The latter reduces the demand for assets that allow to intertemporally transfer resources. Once returns fall short of expectations, investors revise return expectations downward and set in motion a self-reinforcing price bust. In line with available survey data, the learning model predicts return optimism to comove positively with market valuation. In addition, the learning model replicates the low frequency behavior of the U.S. price dividend ratio over the period 1926-2006.
    JEL: G12 D84
    Date: 2010–02
  18. By: Russell Cooper; John Haltiwanger; Jonathan L. Willis
    Abstract: This paper studies capital adjustment at the establishment level. Our goal is to characterize capital adjustment costs, which are important for understanding both the dynamics of aggregate investment and the impact of various policies on capital accumulation. Our estimation strategy searches for parameters that minimize ex post errors in an Euler equation. This strategy is quite common in models for which adjustment occurs in each period. Here, we extend that logic to the estimation of parameters of dynamic optimization problems in which non-convexities lead to extended periods of investment inactivity. In doing so, we create a method to take into account censored observations stemming from intermittent investment. This methodology allows us to take the structural model directly to the data, avoiding time-consuming simulation-based methods. To study the effectiveness of this methodology, we first undertake several Monte Carlo exercises using data generated by the structural model. We then estimate capital adjustment costs for U.S. manufacturing establishments in two sectors.
    Date: 2010
  19. By: Vlieghe, Gertjan (Brevan Howard)
    Abstract: I develop a model for monetary policy analysis that features significant feedback from asset prices to macroeconomic quantities. The feedback is caused by credit market imperfections, which dynamically affect how efficiently labour and capital are being used in aggregate. I then analyse what implications this mechanism has for monetary policy. The paper offers three insights. First, the monetary transmission mechanism works not only via nominal rigidities but also via a reallocation of productive resources away from the most productive agents. Second, following an adverse productivity shock there is a dynamic trade-off between the immediate fall in output, which is an efficient response to the productivity fall, and the fall in output thereafter, which is caused by a reallocation of resources away from the most productive agents. The more the initial output fall is dampened with a temporary rise in inflation, the more the adverse future effects of the reallocation of resources are mitigated. Third, in a full welfare-based analysis of optimal monetary policy I show that it is optimal to have some inflation variability, even if the only shocks in the economy are productivity shocks. The optimal variability of inflation is small, but the costs of stabilising inflation too aggressively can be large.
    JEL: E44 E52
    Date: 2010–03–31
  20. By: Andrés Erosa (IMDEA Ciencias Sociales); Luisa Fuster (IMDEA Ciencias Sociales); Diego Restuccia (University of Toronto)
    Abstract: This paper measures how much of the gender wage gap over the life cycle is due to the fact that working hours are lower for women than for men. We build a quantitative theory of fertility, labor supply, and human capital accumulation decisions to measure gender differences in human capital investments over the life cycle. We assume that there are no gender differences in the human capital technology and calibrate this technology using wage-age profiles of men. The calibration of females assumes that children involve a forced reduction in hours of work that falls on females rather thanon males and that there is an exogenous gender gap in hours of work. We find that our theory accounts for all of the increase in the gender wage gap over the life cycle in the NLSY79 data. The impact of children on the labor supply of females accounts for 56% and 45% of the increase in the gender wage gap over the life cycle among non-college and college individuals, while the rest is due to exogenous gender differences in hours ofwork. We also find that children play an important role in understanding the variationof the gender wage gap across recent cohorts of women and the slower wage growth faced by black women relative to non-black women in the U.S. economy.
    Keywords: gender wage gap; employment; experience; fertility; human capital
    JEL: J2 J3
    Date: 2010–03–25
  21. By: Naohisa Hirakata (Deputy Director, Research and Statistics Department, Bank of Japan. (E-mail:; Nao Sudo (Associate Director, Institute for Monetary and Economic Studies, Bank of Japan. (E-mail:; Kozo Ueda (Director, Institute for Monetary and Economic Studies, Bank of Japan. (E-mail:
    Abstract: Based on the financial accelerator model of Bernanke et al. (1999), we develop a dynamic general equilibrium model for a chain of credit contracts in which financial intermediaries (hereafter FIs) as well as entrepreneurs are subject to credit constraints. Financial intermediation takes place through chained-credit contracts, lending from the market to FIs, and from FIs to entrepreneurs. Calibrated to U.S. data, our model shows that the chained credit contracts enhance the financial accelerator effect, depending on the net worth distribution across sectors: (1) our model reinforces the effects of the net worth shock and the technology shock, compared with a model that omits the FIs' credit friction a la Bernanke et al. (1999); (2) the sectoral shock to FIs has a greater impact than the sectoral shock to entrepreneurs; and (3) the redistribution of net worth from entrepreneurs to FIs reduces the amplification of the technology shock. The key features of the results arise from the asymmetry of the two borrowing sectors: smaller net worth and larger bankruptcy costs of FIs relative to those of entrepreneurs.
    Keywords: Chain of Credit Contracts, Net Worth of Financial Intermediaries, Cross-sectional Net Worth Distribution, Financial Accelerator effect
    JEL: E22 E44
    Date: 2009–11
  22. By: Erzo G.J. Luttmer
    Abstract: The Pareto-like tail of the size distribution of firms can arise from random growth of productivity or stochastic accumulation of capital. If the shocks that give rise to firm growth are perfectly correlated within a firm, then the growth rates of small and large firms are equally volatile, contrary to what is found in the data. If firm growth is the result of many independent shocks within a firm, it can take hundreds of years for a few large firms to emerge. This paper describes an economy with both types of shocks that can account for the thick-tailed firm size distribution, high entry and exit rates, and the relatively young age of large firms. The economy is one in which aggregate growth is driven by the creation of new products by both new and incumbent firms. Some new firms have better ideas than others and choose to implement those ideas at a more rapid pace. Eventually, such firms slow down when the quality of their ideas reverts to the mean. As in the data, average growth rates in a cross section of firms will appear to be independent of firm size, for all but the smallest firms.
    Date: 2010
  23. By: Raouf Boucekkine (CORE, Catholic University of Louvain); Benteng Zou (CREA, University of Luxembourg)
    Abstract: This paper extends the standard neoclassical model by considering a technology sector through which an economy with limited human capital attempts to catch up with a given "locomotive" pushing exogenously technical progress. In periods of technological stagnation, economies close enough to the frontier may find it optimal to not catch up, which reinforces worldwide technological sclerosis. Under sustainable technological growth, all the other economies will sooner or later engage in imitation. Such a phase of technology adoption may be delayed depending on certain deep characteristics of the followers.
    Date: 2010–03

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